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Why Wal-Mart Needs to Build Much Smaller Stores

“Walmart has a long history of embracing change. And this year, we’ll certainly make some changes to improve our business. These changes will be made with a filter on increasing customer relevance.”

That was how Doug McMillon, Wal-Mart Stores’ (WMT) new chief executive officer, introduced his plans for 2014 in a prerecorded call (PDF) on Thursday. What followed were the details of just how tough 2013 was for the world’s biggest retailer. The company’s net sales grew 1.6 percent to $473.1 billion, and its operating income decreased 3.1 percent to $26.9 billion. In the U.S., Wal-Mart’s comparable store sales, an important measure of a retailer’s health, declined 0.6 percent. Company executives have given all sorts of reasons for the slow sales in the U.S.: Some customers are still having a hard time financially; the government reduced food-stamp benefits; the weather was terrible, and the flu season wasn’t.

There was one bright spot: Wal-Mart’s smaller stores. Bill Simon, the head of the retailer’s U.S. operations, noted that the smaller locations (which range in size from 15,000 square feet to 39,000 square feet) had positive comparable sales growth and increases in traffic each quarter of 2013. The grocery stores, called Neighborhood Markets, had sales growth of about 4 percent for the year. Trouble is, there aren’t many of them: 346 to be exact, and only 20 of the even smaller Walmart Express stores. To put that in perspective, the competition—Family Dollar Stores (FDO),Dollar General (DG), and Dollar Tree (DLTR)—have more than 23,000 stores combined.

For Wal-Mart, becoming more relevant to consumers means becoming more convenient. You could run in and out of a dollar store in about the time it takes to find your car in a Walmart Supercenter parking lot. And smaller stores might—just might—be more palatable to cities that have fought against the big-box stores. Simon said Wal-Mart is planning to open between 270 and 300 smaller stores this fiscal year, a big increase from plans revealed back in October to build just 120 to 150 new small stores.

That still seems slow to some. Credit Suisse (CS) analyst Michael Exstein thinks Wal-Mart should just go ahead and buy one of the big dollar-store chains. He suggested Family Dollar, which has more than 7,000 locations across the country. A big merger would be one way for Wal-Mart to get smaller.